Abusive Insurance, Welfare Benefit, and Retirement Plans
The IRS has various task forces auditing all section 419, section 412(i), and other
plans that tend to be abusive. These plans are sold by most insurance agents. The IRS
is looking to raise money and is not looking to correct plans or help taxpayers. The
fines for being in a listed, abusive, or similar transaction are up to $200,000 per year
(section 6707A), unless you report on yourself. The IRS calls accountants, attorneys,
and insurance agents "material advisors" and also fines them the same amount, again
unless the client's participation in the transaction is reported. An accountant is a material
advisor if he signs the return or gives advice and gets paid. More details can be found on
http://www.irs.gov and http://www.vebaplan.com.
Bruce Hink, who has given me written permission to use his name and circumstances,
is a perfect example of what the IRS is doing to unsuspecting business owners. What
follows is a story about how the IRS fines him $200,000 a year for being in what they
called a listed transaction. Listed transactions can be found at http://www.irs.gov. Also
involved are what the IRS calls abusive plans or what it refers to as substantially similar.
Substantially similar to is very difficult to understand, but the IRS seems to be saying, "If
it looks like some other listed transaction, the fines apply." Also, I believe that the
accountant who signed the tax return and the insurance agent who sold the retirement
plan will each be fined $200,000 as material advisors. We have received many calls
for help from accountants, attorneys, business owners, and insurance agents in similar
situations. Don't think this will happen to you? It is happening to a lot of accountants
and business owners, because most of theses so-called listed, abusive, or substantially
similar plans are being sold by insurance agents.
Recently I came across the case of Hink, a small business owner who is facing $400,000
in IRS penalties for 2004 and 2005 because of his participation in a section 412(i) plan.
(The penalties were assessed under section 6707A.)
In 2002 an insurance agent representing a 100-year-old, well established insurance
company suggested the owner start a pension plan. The owner was given a portfolio of
information from the insurance company, which was given to the company's outside CPA
to review and give an opinion on. The CPA gave the plan the green light and the plan
was started.
Contributions were made in 2003. The plan administrator came out with amendments to
the plan, based on new IRS guidelines, in October 2004.
The business owner's insurance agent disappeared in May 2005, before implementing the
new guidelines from the administrator with the insurance company. The business owner
was left with a refund check from the insurance company, a deduction claim on his 2004
tax return that had not been applied, and no agent.
It took six months of making calls to the insurance company to get a new insurance agent
assigned. By then, the IRS had started an examination of the pension plan. Asking
advice from the CPA and a local attorney (who had no previous experience in these
cases) made matters worse, with a "big name" law firm being recommended and over
$30,000 in additional legal fees being billed in three months.
To make a long story short, the audit stretched on for over 2 ½ years to examine a 2-
year-old pension with four participants and the $178,000 in contributions. During the
audit, no funds went to the insurance company, which was awaiting formal IRS approval
on restructuring the plan as a traditional defined benefit plan, which the administrator
had suggested and the IRS had indicated would be acceptable. The $90,000 in 2005
contributions was put into the company's retirement bank account along with the 2004
contributions.
In March 2008 the business owner received a private e-mail apology from the IRS agent
who headed the examination, saying that her hands were tied and that she used to believe
she was correcting problems and helping taxpayers and not hurting people.
The IRS denied any appeal and ruled in October 2008 the $400,000 penalty would stand.
The IRS fine for being in a listed, abusive, or similar transaction is $200,000 per year for
corporations or $100,000 per year for unincorporated entities. The material advisor fine
is $200,000 if you are incorporated or $100,000 if you are not.
Could you or one of your clients be next?
To this point, I have focused, generally, on the horrors of running afoul of the IRS by
participating in a listed transaction, which includes various types of transactions and the
various fines that can be imposed on business owners and their advisors who participate
in, sell, or advice on these transactions. I happened to use, as an example, someone
in a section 412(i) plan, which was deemed to be a listed transaction, pointing out the
truly doleful consequences the person has suffered. Others who fall into this trap, even
unwittingly, can suffer the same fate.
Now let's go into more detail about section 412(i) plans. This is important because these
defined benefit plans are popular and because few people think of retirement plans as
tax shelters or listed transactions. People therefore may get into serious trouble in this
area unwittingly, out of ignorance of the law, and, for the same reason, many fail to take
necessary and appropriate precautions.
The IRS has warned against the section 412(i) defined benefit pension plans, named for
the former code section governing them. It warned against trust arrangements it deems
abusive, some of which may be regarded as listed transactions. Falling into that category
can result in taxpayers having to disclose the participation under pain of penalties,
potentially reaching $100,000 for individuals and $200,000 for other taxpayers. Targets
also include some retirement plans.
One reason for the harsh treatment of some 412(i) plans is their discrimination in favor
of owners and key, highly compensated employees. Also, the IRS does not consider
the promised tax relief proportionate to the economic realities of the transactions. In
general, IRS auditors divide audited plan into those they consider noncompliant and other
they consider abusive. While the alternatives available to the sponsor of noncompliant
plan are problematic, it is frequently an option to keep the plan alive in some form while
simultaneously hoping to minimize the financial fallout from penalties.
The sponsor of an abusive plan can expect to be treated more harshly than participants.
Although in some situation something can be salvaged, the possibility is definitely on
the table of having to treat the plan as if it never existed, which of course triggers the full
extent of back taxes, penalties, and interest on all contributions that were made – not to
mention leaving behind no retirement plan whatsoever.
Another plan the IRS is auditing is the section 419 plan. A few listed transactions
concern relatively common employee benefit plans the IRS has deemed tax avoidance
schemes or otherwise abusive. Perhaps some of the most likely to crop up, especially
in small-business returns, are the arrangements purporting to allow the deductibility of
premiums paid for life insurance under a welfare benefit plan or section 419 plan. These
plans have been sold by most insurance agents and insurance companies.
Some of theses abusive employee benefit plans are represented as satisfying section
419, which sets limits on purposed and balances of "qualified asset accounts" for the
benefits, although the plans purport to offer the deductibility of contributions without
any corresponding income. Others attempt to take advantage of the exceptions to
qualified asset account limits, such as sham union plans that try to exploit the exception
for the separate welfare benefit funds under collective bargaining agreements provided
by section 419A(f)(5). Others try to take advantage of exceptions for plans serving 10
or more employers, once popular under section 419A(f)(6). More recently, one may
encounter plans relying on section 419(e) and, perhaps, defines benefit sections 412(i)
pension plans.
Sections 419 and 419A were added to the code by the Deficit Reduction Act of 1984 in
an attempt to end employers' acceleration of deductions for plan contributions. But it
wasn't long before plan promoters found an end run around the new code sections. An
industry developed in what came to be known as 10-or-more-employer plans.
The IRS steadily added these abusive plans to its designations of listed transactions.
With Revenue Ruling 90-105, it warned against deducting some plan contributions
attributable to compensation earned by plan participants after the end of the tax year.
Purported exceptions to limits of sections 419 and 419A claimed by 10-or-more-
employer benefit funds were likewise prescribed in Notice 95-24 (Doc 95-5046, 95 TNT
98-11). Both positions were designated as listed transactions in 2000.
At that point, where did all those promoters go? Evidence indicates many are now
promoting plans purporting to comply with section 419(e). They are calling a life
insurance plan a welfare benefit plan (or fund), somewhat as they once did, and
promoting the plan as a vehicle to obtain large tax deductions. The only substantial
difference is that theses are now single-employer plans. And again, the IRS has tried
to rein them in, reminding taxpayers that listed transactions include those substantially
similar to any that are specifically described and so designated.
On October 17, 2007, the IRS issues Notices 2007-83 (Doc 2007-23225, 2007 TNT 202-
6) and 2007-84 (Doc 2007-23220, 2007 TNT 202-5). In the former, the IRS identified
some trust arrangements involving cash value life insurance policies, and substantially
similar arrangements, as listed transactions. The latter similarly warned against some
postretirement medical and life insurance benefit arrangements, saying they might be
subject to "alternative tax treatment." The IRS at the same time issued related Rev.
Rul. 2007-65 (Doc 2007-23226, 2007 TNT 202-7) to address situations in which an
arrangement is considered a welfare benefit fund but the employer's deduction for its
contributions to the fund id denied in whole or in part for premiums paid by the trust on
cash value life insurance policies. It states that a welfare benefit fund's qualified direct
cost under section 419 does not include premium amounts paid by the fund for cash value
life insurance policies if the fund is directly or indirectly a beneficiary under the policy,
as determined under sections264(a).
Notice 2007-83 targets promoted arrangements under which the fund trustee purchases
cash value insurance policies on the lives of a business's employee/owners, and
sometimes key employees, while purchasing term insurance policies on the lives of other
employees covered under the plan.
These plans anticipate being terminated and anticipate that the cash value policies will
be distributed to the owners or key employees, with little distributed to other employees.
The promoters claim that the insurance premiums are currently deductible by the business
and that the distributed insurance policies are virtually tax free to the owners. The ruling
makes it clear that, going forward, a business under most circumstances cannot deduct
the cost of premiums paid through a welfare benefit plan for cash value life insurance on
the lives of its employees.
Should a client approach you with one of these plans, be especially cautious, for both
of you. Advise your client to check out the promoter very carefully. Make it clear that
the government has the names of all former section 419A(f)(6) promoters and, therefore,
will be scrutinizing the promoter carefully if the promoter was once active in that area, as
many current section 419(e) (welfare benefit fund or plan) promoters were. This makes
an audit of your client more likely and far riskier.
It is worth noting that listed transactions are subject to a regulatory scheme applicable
only to them, entirely separate from Circular 230 requirements, regulations, and
sanctions. Participation in such a transaction must be disclosed on a tax return, and the
penalties for failure to disclose are severe – up to $100,000 for individuals and $200,000
for corporations. The penalties apply to both taxpayers and practitioners. And the
problem with disclosure, of course, is that it is apt to trigger an audit, in which case even
if the listed transaction was to pass muster, something else may not.
Showing posts with label Insurance. Show all posts
Showing posts with label Insurance. Show all posts
419 Insurance Welfare Benefit Plans Continue To Get Accountants Into Trouble
Popular so-called “419 Insurance Welfare Benefit Plans”, sold by most insurance professionals, are getting accountants and their clients into more and more trouble. A CPA who is approached by a client about one of the abusive arrangements and/or situations to be described and discussed in this article must exercise the utmost degree of caution, not only on behalf of the client, but for his/her own good as well. The penalties noted in this article can also be applied to practitioners who prepare and/or sign returns that fail to properly disclose listed transactions, including those discussed herein.
On October 17, 2007, the IRS issued Notice 2007-83, Notice 2007-84, and Revenue Ruling 2007-65. Notice 2007-83 essentially lists the characteristics of welfare benefit plans that the Service regards as listed transactions. Put simply, to be a listed transaction, a plan cannot rely on the union exception set forth in IRC Section 419A(f)(5),there must be cash value life insurance within the plan and excessive tax deductions for life insurance, in excess of what may be permitted by Sections 419 and 419A, must have been claimed.
In Notice 2007-84, the Service expressed concern with plans that provide all or a substantial portion of benefits to owners and/or key and highly compensated employees. The notice identified numerous specific concerns, among them:
1. The granting of loans to participants
2. Providing deferred compensation
3. Plan terminations that result in the distribution of assets rather than being used post-retirement, as originally established.
4. Permitting the transfer of life insurance policies to participants.
Alternative tax treatment may well be in the offing for such arrangements, as the IRS intends to re-characterize such arrangements as dividends, non-qualified deferred compensation (under IRC Section 404(a)(5) or Section 409(A), split-dollar life insurance arrangements, or disqualified benefits pursuant to Section 4976. Taxpayers participating in these listed transactions should have, in most cases, already disclosed such participation to the Service. Those who have not should do so at the earliest possible moment. Failure to disclose can result in severe penalties – up to $100,000 for individuals and $200,000 for corporations.
Finally, Revenue Ruling 2007-65 focused on situations where cash value life insurance is purchased on owner employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419A (f)(6), and 419 plans. Life insurance premiums are not inherently tax deductible and authority must be found in Section 79 to justify such a deduction. Section 264(a), in fact, specifically disallows tax deductions for life insurance, at least in some cases. And moreover, the Service declared, interposition of a trust does not change the nature of the transaction.
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He speaks at more than 70 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, visit www.vebaplan.com or call 516-938-5007.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
On October 17, 2007, the IRS issued Notice 2007-83, Notice 2007-84, and Revenue Ruling 2007-65. Notice 2007-83 essentially lists the characteristics of welfare benefit plans that the Service regards as listed transactions. Put simply, to be a listed transaction, a plan cannot rely on the union exception set forth in IRC Section 419A(f)(5),there must be cash value life insurance within the plan and excessive tax deductions for life insurance, in excess of what may be permitted by Sections 419 and 419A, must have been claimed.
In Notice 2007-84, the Service expressed concern with plans that provide all or a substantial portion of benefits to owners and/or key and highly compensated employees. The notice identified numerous specific concerns, among them:
1. The granting of loans to participants
2. Providing deferred compensation
3. Plan terminations that result in the distribution of assets rather than being used post-retirement, as originally established.
4. Permitting the transfer of life insurance policies to participants.
Alternative tax treatment may well be in the offing for such arrangements, as the IRS intends to re-characterize such arrangements as dividends, non-qualified deferred compensation (under IRC Section 404(a)(5) or Section 409(A), split-dollar life insurance arrangements, or disqualified benefits pursuant to Section 4976. Taxpayers participating in these listed transactions should have, in most cases, already disclosed such participation to the Service. Those who have not should do so at the earliest possible moment. Failure to disclose can result in severe penalties – up to $100,000 for individuals and $200,000 for corporations.
Finally, Revenue Ruling 2007-65 focused on situations where cash value life insurance is purchased on owner employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419A (f)(6), and 419 plans. Life insurance premiums are not inherently tax deductible and authority must be found in Section 79 to justify such a deduction. Section 264(a), in fact, specifically disallows tax deductions for life insurance, at least in some cases. And moreover, the Service declared, interposition of a trust does not change the nature of the transaction.
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He speaks at more than 70 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, visit www.vebaplan.com or call 516-938-5007.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
A Rose By Any Other Name, or...Whatever Happened to All Those 419A(f)(6) Providers?
Enrolled Agents Journal March*April 2006
A Rose By Any Other Name, or
Whatever Happened to All Those 419A(f)(6) Providers?
By Ronald H. Snyder, JD, MAAA, EA & Lance Wallach, CLU, ChFC, CIMC
For years promoters of life insurance companies and agents have tried to find ways of claiming that the premiums paid by business owners were tax deductible. This allowed them to sell policies at a “discount”.
The problem became especially bad a few years ago with all of the outlandish claims about how §§419A(f)(5) and 419A(f)(6) exempted employers from any tax deduction limits. Many other inaccurate statements were made as well, until the IRS finally put a stop to such assertions by issuing regulations and naming such plans as “potentially abusive tax shelters” (or “listed transactions”) that needed to be disclosed and registered. This appeared to put an end to the scourge of such scurrilous promoters, as such plans began to disappear from the landscape.
And what happened to all the providers that were peddling 419A(f)(5) and (6) life insurance plans a couple of years ago? We recently found the answer: most of them found a new life as promoters of so-called “419(e)” welfare benefit plans.
We recently reviewed several §419(e) plans, and it appears that many of them are nothing more than recycled §419A(f)(5) and §419A(f)(6) plans.
The “Tax Guide” written by one vendor’s attorney is illustrative: he confuses the difference between a “multi-employer trust” (a Taft-Hartley, collectively-bargained plan), a “multiple-employer trust” (a plan with more than one unrelated employer) and a “10-or-more employer trust” (a plan seeking to comply with IRC §419A(f)(6)).
Background: Section 419 of the Internal Revenue Code
Section 419 was added to the Internal Revenue Code (“IRC”) in 1984 to curb abuses in welfare benefit plan tax deductions. §419(a) does not authorize tax deductions, but provides as follows: “Contributions paid or accrued by an employer to a welfare benefit fund * * * shall not be deductible under this chapter * * *.”. It simply limits the amount that would be deductible under another IRC section to the “qualified cost for the taxable year”. (§419(b))
Section 419(e) of the IRC defines a “welfare benefit fund” as “any fund-- (A) which is part of a plan of an employer, and (B) through which the employer provides welfare benefits to employees or their beneficiaries.” It also defines the term "fund", but excludes from that definition “amounts held by an insurance company pursuant to an insurance contract” under conditions described.
None of the vendors provides an analysis under §419(e) as to whether or not the life insurance policies they promote are to be included or excluded from the definition of a “fund”. In fact, such policies will be included and therefore subject to the limitations of §§419 and 419A.
Errors Commonly Made
Materials from the various plans commonly make several mistakes in their analyses:
1. They claim not to be required to comply with IRC §505 non-discrimination requirements. While it is true that §505 specifically lists “organizations described in paragraph (9) or (20) of section 501(c)”, IRC §4976 imposes a 100% excise tax on any “post-retirement medical benefit or life insurance benefit provided with respect to a key employee” * * * “unless the plan meets the requirements of section 505(b) with respect to such benefit (whether or not such requirements apply to such plan).” (Italics added) Failure to comply with §505(b) means that the plan will never be able to distribute an insurance policy to a key employee without the 100% penalty!
2. Vendors commonly assert that contributions to their plan are tax deductible because they fall within the limitations imposed under IRC §419; however, §419 is simply a limitation on tax deductions. Providers must cite the section of the IRC under which contributions to their plan would be tax-deductible. Many fail to do so. Others claim that the deductions are ordinary and necessary business expense under §162, citing Regs. §1.162-10 in error: there is no mention in that section of life insurance or a death benefit as a welfare benefit.
3. The reason that promoters fail to cite a section of the IRC to support a tax deduction is because, once such section is cited, it becomes apparent that their method of covering only selected key and highly-compensated employees for participation in the plan fails to comply with IRC §414(t) requirements relative to coverage of controlled groups and affiliated service groups.
4. Life insurance premiums could be treated as W-2 wages and deducted under §162 to the extent they were reasonable. Other than that, however, no section of the Internal Revenue Code authorizes tax deductions for a discriminatory life insurance arrangement. IRC §264(a) provides that “[n]o deduction shall be allowed for * * * [p]remiums on any life insurance policy * * * if the taxpayer is directly or indirectly a beneficiary under the policy.” As was made clear in the Neonatology case (Neonatology Associates v. Commissioner, 115 TC 5, 2000), the appropriate treatment of employer-paid life insurance premiums under a putative welfare benefit plan is under §79, which comes with its own nondiscrimination requirements.
5. Some plans claim to impute income for current protection under the PS 58 rules. However, PS58 treatment is available only to qualified retirement plans and split-dollar plans. (Note: none of the 419(e) plans claim to comply with the split-dollar regulations.) Income is imputed under Table I to participants under Group-Term Life Insurance plans that comply with §79. This issue is addressed in footnotes 17 and 18 of the Neonatology case.
6. Several of the plans claim to be exempt from ERISA. They appear to rely upon the ERISA Top-Hat exemption (applicable to deferred compensation plans). However, that only exempts a plan from certain ERISA requirements, not ERISA itself. It is instructive that none of the plans claiming exemption from ERISA has filed the Top-Hat notification with the Dept. of Labor.
7. Some of the plans offer severance benefits as a “welfare benefit”, which approach has never been approved by the IRS. Other plans offer strategies for obtaining a cash benefit by terminating a single-employer trust. The distribution of a cash benefit is a form of deferred compensation, yet none of the plans offering such benefit complies with the IRC §409A requirements applicable to such benefits.
8. Some vendors permit participation by employees who are self-employed, such as sole proprietors, partners or members of an LLC or LLP taxed as a partnership. This issue was also addressed in the Neonatology case where contributions on behalf of such persons were deemed to be dividends or personal payments rather than welfare benefit plan expenses.
[Note: bona fide employees of an LLC or LLP that has elected to be taxed as a corporation may participate in a plan.]
9. Most of the plans fail under §419 itself. §419(c) limits the current tax deduction to the “qualified cost”, which includes the “qualified direct cost” and additions to a “qualified asset account” (subject to the limits of §419A(b)). Under Regs. §1.419-1T, A-6, “the "qualified direct cost" of a welfare benefit fund for any taxable year * * * is the aggregate amount which would have been allowable as a deduction to the employer for benefits provided by such fund during such year (including insurance coverage for such year) * * *.” “Thus, for example, if a calendar year welfare benefit fund pays an insurance company * * * the full premium for coverage of its current employees under a term * * * insurance policy, * * * only the portion of the premium for coverage during [the year] will be treated as a "qualified direct cost" * * *.” (Italics added)
Most vendors pretend that the whole or universal life insurance premium is an appropriate measurement of cost for Key Employees, and those plans that cover rank and file employees use current term insurance premiums as the appropriate measure of cost for such employees. This approach doesn’t meet any set of nondiscrimination requirements applicable to such plans.
10. Some vendors claim that they are justified in providing a larger deduction than the amount required to pay term insurance costs for the current tax year, but, as cited above, the only justification under §419(e) itself is as additions to a qualified asset account and is subject to the limitations imposed by §419A. In addition, §419A adds several additional limitations to plans and contributions, including requirements that:
A. contributions be limited to a safe harbor amount or be certified by an actuary as to the amount of such contributions (§419A(c)(5));
B. actuarial assumptions be “reasonable in the aggregate” and that the actuary use a level annual cost method (§419A(c)(2));
C. benefits with respect to a Key Employee be segregated and their benefits can only be paid from such account (§419A(d));
D. the rules of subsections (b), (c), (m), and (n) of IRC section 414 shall apply to such plans (§419A(h)).
E. the plan comply with §505(b) nondiscrimination requirements (§419A(e)).
Circular 230 Issues
Circular 230 imposes many requirements on tax professionals with respect to tax shelter transactions. A tax practitioner can get into trouble in the promotion of such plans, in advising clients with respect to such transactions and in preparing tax returns. IRC §§6707 and 6707A add a new concept of “reportable transactions” and impose substantial penalties for failure to disclose participation in certain reportable transactions (including all listed transactions).
This is a veritable minefield for tax practitioners to negotiate carefully or avoid altogether. The advisor must exercise great caution and due diligence when presented with any potential contemplated tax reduction or avoidance transaction. Failure to disclose could subject taxpayers and their tax advisors to potentially Draconian penalties.
Summary
Key points of this article include:
· Practitioners need to be able to differentiate between a legitimate §419(e) plan and one that is legally inadequate when their client approaches them with respect to such plan or has the practitioner to prepare his return;
· Many plans incorrectly purport to be exempt from compliance with ERISA, IRC §§414, 505, 79, etc.
· Tax deductions must be claimed under an authorizing section of the IRC and are limited to the qualified direct cost and additions to a qualified asset account as certified by the plan’s actuary.
Conclusion
Irresponsible vendors such as most of the promoters who previously promoted IRC §419A(f)(6) plans were responsible for the IRS’s issuing restrictive regulations under that Section. Now many of the same individuals have elected simply to claim that a life insurance plan is a welfare benefit plan and therefore tax-deductible because it uses a single-employer trust rather than a "10-or-more-employer plan".
This is an open invitation to the IRS to issue new onerous Regulations and more indictments and legal actions against the unscrupulous promoters who feed off of the naivety of clients and the greed of life insurance companies who encourage and endorse (and even own) such plans.
The last line of defense of the innocent client is the accountant or attorney who is asked by a client to review such arrangement or prepare a tax return claiming a deduction for contributions to such a plan. Under these circumstances accountants and attorneys should be careful not to rely upon the materials made available by the plan vendors, but should review any proposed plan thoroughly, or refer the review to a specialist.
Ron Snyder practices as an ERISA attorney and Enrolled Actuary in the field of employee benefits.
Lance Wallach speaks and writes extensively about VEBAs retirement plans, and tax reduction strategies. He speaks at more than 70 conventions annually and writes for more than 50 publications. For more information and additional articles on these subjects, call 516-938-5007 or visit www.vebaplan.com..
This information is not intended as legal, accounting, financial, or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
A Rose By Any Other Name, or
Whatever Happened to All Those 419A(f)(6) Providers?
By Ronald H. Snyder, JD, MAAA, EA & Lance Wallach, CLU, ChFC, CIMC
For years promoters of life insurance companies and agents have tried to find ways of claiming that the premiums paid by business owners were tax deductible. This allowed them to sell policies at a “discount”.
The problem became especially bad a few years ago with all of the outlandish claims about how §§419A(f)(5) and 419A(f)(6) exempted employers from any tax deduction limits. Many other inaccurate statements were made as well, until the IRS finally put a stop to such assertions by issuing regulations and naming such plans as “potentially abusive tax shelters” (or “listed transactions”) that needed to be disclosed and registered. This appeared to put an end to the scourge of such scurrilous promoters, as such plans began to disappear from the landscape.
And what happened to all the providers that were peddling 419A(f)(5) and (6) life insurance plans a couple of years ago? We recently found the answer: most of them found a new life as promoters of so-called “419(e)” welfare benefit plans.
We recently reviewed several §419(e) plans, and it appears that many of them are nothing more than recycled §419A(f)(5) and §419A(f)(6) plans.
The “Tax Guide” written by one vendor’s attorney is illustrative: he confuses the difference between a “multi-employer trust” (a Taft-Hartley, collectively-bargained plan), a “multiple-employer trust” (a plan with more than one unrelated employer) and a “10-or-more employer trust” (a plan seeking to comply with IRC §419A(f)(6)).
Background: Section 419 of the Internal Revenue Code
Section 419 was added to the Internal Revenue Code (“IRC”) in 1984 to curb abuses in welfare benefit plan tax deductions. §419(a) does not authorize tax deductions, but provides as follows: “Contributions paid or accrued by an employer to a welfare benefit fund * * * shall not be deductible under this chapter * * *.”. It simply limits the amount that would be deductible under another IRC section to the “qualified cost for the taxable year”. (§419(b))
Section 419(e) of the IRC defines a “welfare benefit fund” as “any fund-- (A) which is part of a plan of an employer, and (B) through which the employer provides welfare benefits to employees or their beneficiaries.” It also defines the term "fund", but excludes from that definition “amounts held by an insurance company pursuant to an insurance contract” under conditions described.
None of the vendors provides an analysis under §419(e) as to whether or not the life insurance policies they promote are to be included or excluded from the definition of a “fund”. In fact, such policies will be included and therefore subject to the limitations of §§419 and 419A.
Errors Commonly Made
Materials from the various plans commonly make several mistakes in their analyses:
1. They claim not to be required to comply with IRC §505 non-discrimination requirements. While it is true that §505 specifically lists “organizations described in paragraph (9) or (20) of section 501(c)”, IRC §4976 imposes a 100% excise tax on any “post-retirement medical benefit or life insurance benefit provided with respect to a key employee” * * * “unless the plan meets the requirements of section 505(b) with respect to such benefit (whether or not such requirements apply to such plan).” (Italics added) Failure to comply with §505(b) means that the plan will never be able to distribute an insurance policy to a key employee without the 100% penalty!
2. Vendors commonly assert that contributions to their plan are tax deductible because they fall within the limitations imposed under IRC §419; however, §419 is simply a limitation on tax deductions. Providers must cite the section of the IRC under which contributions to their plan would be tax-deductible. Many fail to do so. Others claim that the deductions are ordinary and necessary business expense under §162, citing Regs. §1.162-10 in error: there is no mention in that section of life insurance or a death benefit as a welfare benefit.
3. The reason that promoters fail to cite a section of the IRC to support a tax deduction is because, once such section is cited, it becomes apparent that their method of covering only selected key and highly-compensated employees for participation in the plan fails to comply with IRC §414(t) requirements relative to coverage of controlled groups and affiliated service groups.
4. Life insurance premiums could be treated as W-2 wages and deducted under §162 to the extent they were reasonable. Other than that, however, no section of the Internal Revenue Code authorizes tax deductions for a discriminatory life insurance arrangement. IRC §264(a) provides that “[n]o deduction shall be allowed for * * * [p]remiums on any life insurance policy * * * if the taxpayer is directly or indirectly a beneficiary under the policy.” As was made clear in the Neonatology case (Neonatology Associates v. Commissioner, 115 TC 5, 2000), the appropriate treatment of employer-paid life insurance premiums under a putative welfare benefit plan is under §79, which comes with its own nondiscrimination requirements.
5. Some plans claim to impute income for current protection under the PS 58 rules. However, PS58 treatment is available only to qualified retirement plans and split-dollar plans. (Note: none of the 419(e) plans claim to comply with the split-dollar regulations.) Income is imputed under Table I to participants under Group-Term Life Insurance plans that comply with §79. This issue is addressed in footnotes 17 and 18 of the Neonatology case.
6. Several of the plans claim to be exempt from ERISA. They appear to rely upon the ERISA Top-Hat exemption (applicable to deferred compensation plans). However, that only exempts a plan from certain ERISA requirements, not ERISA itself. It is instructive that none of the plans claiming exemption from ERISA has filed the Top-Hat notification with the Dept. of Labor.
7. Some of the plans offer severance benefits as a “welfare benefit”, which approach has never been approved by the IRS. Other plans offer strategies for obtaining a cash benefit by terminating a single-employer trust. The distribution of a cash benefit is a form of deferred compensation, yet none of the plans offering such benefit complies with the IRC §409A requirements applicable to such benefits.
8. Some vendors permit participation by employees who are self-employed, such as sole proprietors, partners or members of an LLC or LLP taxed as a partnership. This issue was also addressed in the Neonatology case where contributions on behalf of such persons were deemed to be dividends or personal payments rather than welfare benefit plan expenses.
[Note: bona fide employees of an LLC or LLP that has elected to be taxed as a corporation may participate in a plan.]
9. Most of the plans fail under §419 itself. §419(c) limits the current tax deduction to the “qualified cost”, which includes the “qualified direct cost” and additions to a “qualified asset account” (subject to the limits of §419A(b)). Under Regs. §1.419-1T, A-6, “the "qualified direct cost" of a welfare benefit fund for any taxable year * * * is the aggregate amount which would have been allowable as a deduction to the employer for benefits provided by such fund during such year (including insurance coverage for such year) * * *.” “Thus, for example, if a calendar year welfare benefit fund pays an insurance company * * * the full premium for coverage of its current employees under a term * * * insurance policy, * * * only the portion of the premium for coverage during [the year] will be treated as a "qualified direct cost" * * *.” (Italics added)
Most vendors pretend that the whole or universal life insurance premium is an appropriate measurement of cost for Key Employees, and those plans that cover rank and file employees use current term insurance premiums as the appropriate measure of cost for such employees. This approach doesn’t meet any set of nondiscrimination requirements applicable to such plans.
10. Some vendors claim that they are justified in providing a larger deduction than the amount required to pay term insurance costs for the current tax year, but, as cited above, the only justification under §419(e) itself is as additions to a qualified asset account and is subject to the limitations imposed by §419A. In addition, §419A adds several additional limitations to plans and contributions, including requirements that:
A. contributions be limited to a safe harbor amount or be certified by an actuary as to the amount of such contributions (§419A(c)(5));
B. actuarial assumptions be “reasonable in the aggregate” and that the actuary use a level annual cost method (§419A(c)(2));
C. benefits with respect to a Key Employee be segregated and their benefits can only be paid from such account (§419A(d));
D. the rules of subsections (b), (c), (m), and (n) of IRC section 414 shall apply to such plans (§419A(h)).
E. the plan comply with §505(b) nondiscrimination requirements (§419A(e)).
Circular 230 Issues
Circular 230 imposes many requirements on tax professionals with respect to tax shelter transactions. A tax practitioner can get into trouble in the promotion of such plans, in advising clients with respect to such transactions and in preparing tax returns. IRC §§6707 and 6707A add a new concept of “reportable transactions” and impose substantial penalties for failure to disclose participation in certain reportable transactions (including all listed transactions).
This is a veritable minefield for tax practitioners to negotiate carefully or avoid altogether. The advisor must exercise great caution and due diligence when presented with any potential contemplated tax reduction or avoidance transaction. Failure to disclose could subject taxpayers and their tax advisors to potentially Draconian penalties.
Summary
Key points of this article include:
· Practitioners need to be able to differentiate between a legitimate §419(e) plan and one that is legally inadequate when their client approaches them with respect to such plan or has the practitioner to prepare his return;
· Many plans incorrectly purport to be exempt from compliance with ERISA, IRC §§414, 505, 79, etc.
· Tax deductions must be claimed under an authorizing section of the IRC and are limited to the qualified direct cost and additions to a qualified asset account as certified by the plan’s actuary.
Conclusion
Irresponsible vendors such as most of the promoters who previously promoted IRC §419A(f)(6) plans were responsible for the IRS’s issuing restrictive regulations under that Section. Now many of the same individuals have elected simply to claim that a life insurance plan is a welfare benefit plan and therefore tax-deductible because it uses a single-employer trust rather than a "10-or-more-employer plan".
This is an open invitation to the IRS to issue new onerous Regulations and more indictments and legal actions against the unscrupulous promoters who feed off of the naivety of clients and the greed of life insurance companies who encourage and endorse (and even own) such plans.
The last line of defense of the innocent client is the accountant or attorney who is asked by a client to review such arrangement or prepare a tax return claiming a deduction for contributions to such a plan. Under these circumstances accountants and attorneys should be careful not to rely upon the materials made available by the plan vendors, but should review any proposed plan thoroughly, or refer the review to a specialist.
Ron Snyder practices as an ERISA attorney and Enrolled Actuary in the field of employee benefits.
Lance Wallach speaks and writes extensively about VEBAs retirement plans, and tax reduction strategies. He speaks at more than 70 conventions annually and writes for more than 50 publications. For more information and additional articles on these subjects, call 516-938-5007 or visit www.vebaplan.com..
This information is not intended as legal, accounting, financial, or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
The Advisor’s Guide to Premium Financing
Published in: California Broker Magazine - Oct. 2008
Premium financing allows your clients to purchase life insurance without liquidating their investments or changing their cash flow. Clients who are most likely to use premium financing are high net-worth seniors who are over 70.However, younger people can benefit with alternative forms of financing, other than through a bank.
It began in 1973 with the financing o property and casualty insurance policies. In1995, lending companies started financing life insurance policies. Ever since then, the life insurance industry and lending institutions have been developing innovative designs and products.
Premium financing can answer some of the objections people have to life insurance. Most have an aversion to paying premiums and to dealing with matters relating to death, especially when someone else is profiting. It allows clients to do the following:
• Retain capital for lifestyle and investment needs.
• Have additional liquidity for a family or business or additional liquidity to pay taxes on the value of a business.
• Eliminate unnecessary gifting or use of their unified credit. (Premium financing does not impede unified credit or annual gifting.)
• Avoid or reduce estate, inheritance, and generation-skipping taxes.
Why Premium Financing is Getting Popular
Many consumers are finding that it is not cost efficient to purchase life insurance by paying term or permanent premiums. Premium financing may provide more favorable financial terms for clients who are seeking to purchase life insurance.
Many people don’t have adequate pro-tection for their financial legacies. People are living longer and our economy is producing many multi-millionaires, which creates larger estates. At the same time, estate tax laws are subject to change. Premium financing does not interfere with estate planning strategies including genera-tion skipping.
The grantor/insured can loan annual life insurance premiums to the ILIT rather than gifting them when the ILIT owns the policy. IRS Letter Ruling 9809032 declares that a loan to an ILIT is not an incident of ownership. The grantor/insured is not responsible for the premium finance loan. The ILIT repays the loan when it receives the death proceeds.
Premium financing eliminates annual gift-ing issues that can come up with an ILIT. It provides substantial leverage for the gift tax. Under IRC Code 7872, if paid by the grantor, only the loan interest is considered an annual gift rather than the entire premi-um. There could be a gifting problem if the contract has been classified as a modified endowment contract. However, this issue should never arise unless the client tries to make a single premium deposit into the contract. When the insurance policy is issued, it is designed so that it is not classified as a modified endowment contract.
ILIT deposits are transferred irrevocably, which means that the money cannot be used for alternative investments or used to improve a person’s lifestyle.
Premium financing enables the trust to receive death proceeds income-tax-free without including them in the insured’s estate. Total death proceeds are not included in the insured’s estate if the ILIT trust has been arranged properly.
Premium Finance Loans
The four major steps of premium financing are to get a policy, create an irrevocable life insurance trust (ILIT), obtain a loan, and collateralize the loan. A third-party lending institution finances the life insurance pre-mums. A trust owns the policy, keeping the death benefit out of the estate. Through the trust, the insurance policy is assigned to the third-party lender as collateral.
The two general types of premium finance loans are “interest paid” and “inter-est accrued.”
When your client pays interest out of pocket, they avoid additional deferred risk by tying up collateral for a longer period .Also, your client does not need additional collateral. The disadvantage is that the money your client pays out-of-pocket could be used for investments or for main-tenance of their lifestyle.
The following are the usual terms of an interest-accrued loan:
• Interest is accrued for the length of loan, which is generally five to 10 years.
• The borrower must show financial ability to pay the premiums and interest even though the premiums are being financed.
• The borrower must be able to post additional collateral for as long as necessary if the policy surrender values are insufficient in any given year. The lender per-forms a collateral analysis each year to determine if there is a shortage. This is normally is done 45 days before the anniversary date to give the client enough time to post additional collateral.
• The borrower must give the lender a cover letter explaining why interest is being accrued. They must also provide their estate planning strategy.
• The amount of life insurance the borrow-er purchases cannot exceed their ne tworth. Also, the borrower’s projected net worth cannot be less then the projected accrued loan. If the lender’s risk analysis indicates that the borrower’s projected net worth is less, the borrower has to apply for less life insurance coverage.
The accrued interest loan creates future deferred risk. The London Interbank Offered Rate (LIBOR) is used as a base index for setting rates of some adjustable rate mortgages and other loans.
Suppose LIBOR loan rates continued to increase instead of leveling off and eventu-ally decreasing to their long-term average rates. Every year, the corresponding life insurance product would be under extreme pressure to produce crediting rates that exceeded the LIBOR rate.
Collateral could be put at risk if the loan balance increased while the policy’s cash value did not. It could create the need for additional collateral, which the client may not have. When bank loans have com-pounding non-fixed interest, the annual interest payment could end of being high-er than the annual premium payment. This is particularly true with younger clients.
There are ways to avoid the pitfalls of the interest-accrued loan. Creative financing can offer interest accrued loans with the following advantages:
• Non-recourse
• Unlimited term
• Fixed interest rates as low as 3%
• Non-compounding of interest
• No additional collateral requirement Why Universal Life Is Not a Good Choice
Traditional universal life is the most com-mon life insurance product to be used for premium financing and is most commonly accepted by lending institutions. However, it should not be used for premium financing in today’s interest rate environment for the following reasons:
• The current crediting rate for most UL policies is too low.
• The guaranteed rate for most UL policies is 4%. This is also the current rate for some companies.
• Long-term surrender charges cause additional collateral shortages.
• Death benefits are falling short of what was targeted.
• An insurance company generally invests in medium-term maturity fixed-income instruments, primarily notes. Bond fund yields tend to fluctuate more slowly than do money market interest rates. Short-term interest rates fluctuate rapidly while the portfolio yields are slower to react.
• The interest rates charged on premium finance loans are greater than current portfolio yields. This may continue for several years before portfolio rates catch up. Annual shortages will increase if this continues for many years while interest is accruing. There would be a concern about whether the premium finance arrangement could continue.
Equity-Indexed UL –an Acceptable Alternative
Equity-indexed universal life insurance is an acceptable alternative for premium financing. A critical difference sets it apart from other flexible premium UL products. The carrier can credit interest that is based partly on the potential growth of an out-side index (excluding dividends). At the same time, none of the policyholder’s cash value participates directly in an equity market. This probably provides better long-term values than a fixed universal life product can provide. It also creates less risk to principal than a variable universal life product brings.
There is a way to avoid losing the death benefit as interest accrues. Special insurance riders increase the death benefit each year by the amount of interest on the pre-mium finance loan. This is called a“return-of interest/cost of money rider.”The death benefit will not get eaten away by accrued interest when combined with a standard return-of-premium rider. Ben-eficiaries always receive the original death benefit.
In short, premium financing can allow your client to protect their net worth and pass along their financial legacy to future generations without altering other financial strategies.
––––––––––
Lance Wallach, CLU, ChFC, the National Society of Accountants Speaker of the Year, speaks at more than 70 national conventions annually and writes for more than 50 national publications about financial planning, retirement plans, and tax reduction. For more information, visitwww.vebaplan.com or call 516-938-5007.
Premium financing allows your clients to purchase life insurance without liquidating their investments or changing their cash flow. Clients who are most likely to use premium financing are high net-worth seniors who are over 70.However, younger people can benefit with alternative forms of financing, other than through a bank.
It began in 1973 with the financing o property and casualty insurance policies. In1995, lending companies started financing life insurance policies. Ever since then, the life insurance industry and lending institutions have been developing innovative designs and products.
Premium financing can answer some of the objections people have to life insurance. Most have an aversion to paying premiums and to dealing with matters relating to death, especially when someone else is profiting. It allows clients to do the following:
• Retain capital for lifestyle and investment needs.
• Have additional liquidity for a family or business or additional liquidity to pay taxes on the value of a business.
• Eliminate unnecessary gifting or use of their unified credit. (Premium financing does not impede unified credit or annual gifting.)
• Avoid or reduce estate, inheritance, and generation-skipping taxes.
Why Premium Financing is Getting Popular
Many consumers are finding that it is not cost efficient to purchase life insurance by paying term or permanent premiums. Premium financing may provide more favorable financial terms for clients who are seeking to purchase life insurance.
Many people don’t have adequate pro-tection for their financial legacies. People are living longer and our economy is producing many multi-millionaires, which creates larger estates. At the same time, estate tax laws are subject to change. Premium financing does not interfere with estate planning strategies including genera-tion skipping.
The grantor/insured can loan annual life insurance premiums to the ILIT rather than gifting them when the ILIT owns the policy. IRS Letter Ruling 9809032 declares that a loan to an ILIT is not an incident of ownership. The grantor/insured is not responsible for the premium finance loan. The ILIT repays the loan when it receives the death proceeds.
Premium financing eliminates annual gift-ing issues that can come up with an ILIT. It provides substantial leverage for the gift tax. Under IRC Code 7872, if paid by the grantor, only the loan interest is considered an annual gift rather than the entire premi-um. There could be a gifting problem if the contract has been classified as a modified endowment contract. However, this issue should never arise unless the client tries to make a single premium deposit into the contract. When the insurance policy is issued, it is designed so that it is not classified as a modified endowment contract.
ILIT deposits are transferred irrevocably, which means that the money cannot be used for alternative investments or used to improve a person’s lifestyle.
Premium financing enables the trust to receive death proceeds income-tax-free without including them in the insured’s estate. Total death proceeds are not included in the insured’s estate if the ILIT trust has been arranged properly.
Premium Finance Loans
The four major steps of premium financing are to get a policy, create an irrevocable life insurance trust (ILIT), obtain a loan, and collateralize the loan. A third-party lending institution finances the life insurance pre-mums. A trust owns the policy, keeping the death benefit out of the estate. Through the trust, the insurance policy is assigned to the third-party lender as collateral.
The two general types of premium finance loans are “interest paid” and “inter-est accrued.”
When your client pays interest out of pocket, they avoid additional deferred risk by tying up collateral for a longer period .Also, your client does not need additional collateral. The disadvantage is that the money your client pays out-of-pocket could be used for investments or for main-tenance of their lifestyle.
The following are the usual terms of an interest-accrued loan:
• Interest is accrued for the length of loan, which is generally five to 10 years.
• The borrower must show financial ability to pay the premiums and interest even though the premiums are being financed.
• The borrower must be able to post additional collateral for as long as necessary if the policy surrender values are insufficient in any given year. The lender per-forms a collateral analysis each year to determine if there is a shortage. This is normally is done 45 days before the anniversary date to give the client enough time to post additional collateral.
• The borrower must give the lender a cover letter explaining why interest is being accrued. They must also provide their estate planning strategy.
• The amount of life insurance the borrow-er purchases cannot exceed their ne tworth. Also, the borrower’s projected net worth cannot be less then the projected accrued loan. If the lender’s risk analysis indicates that the borrower’s projected net worth is less, the borrower has to apply for less life insurance coverage.
The accrued interest loan creates future deferred risk. The London Interbank Offered Rate (LIBOR) is used as a base index for setting rates of some adjustable rate mortgages and other loans.
Suppose LIBOR loan rates continued to increase instead of leveling off and eventu-ally decreasing to their long-term average rates. Every year, the corresponding life insurance product would be under extreme pressure to produce crediting rates that exceeded the LIBOR rate.
Collateral could be put at risk if the loan balance increased while the policy’s cash value did not. It could create the need for additional collateral, which the client may not have. When bank loans have com-pounding non-fixed interest, the annual interest payment could end of being high-er than the annual premium payment. This is particularly true with younger clients.
There are ways to avoid the pitfalls of the interest-accrued loan. Creative financing can offer interest accrued loans with the following advantages:
• Non-recourse
• Unlimited term
• Fixed interest rates as low as 3%
• Non-compounding of interest
• No additional collateral requirement Why Universal Life Is Not a Good Choice
Traditional universal life is the most com-mon life insurance product to be used for premium financing and is most commonly accepted by lending institutions. However, it should not be used for premium financing in today’s interest rate environment for the following reasons:
• The current crediting rate for most UL policies is too low.
• The guaranteed rate for most UL policies is 4%. This is also the current rate for some companies.
• Long-term surrender charges cause additional collateral shortages.
• Death benefits are falling short of what was targeted.
• An insurance company generally invests in medium-term maturity fixed-income instruments, primarily notes. Bond fund yields tend to fluctuate more slowly than do money market interest rates. Short-term interest rates fluctuate rapidly while the portfolio yields are slower to react.
• The interest rates charged on premium finance loans are greater than current portfolio yields. This may continue for several years before portfolio rates catch up. Annual shortages will increase if this continues for many years while interest is accruing. There would be a concern about whether the premium finance arrangement could continue.
Equity-Indexed UL –an Acceptable Alternative
Equity-indexed universal life insurance is an acceptable alternative for premium financing. A critical difference sets it apart from other flexible premium UL products. The carrier can credit interest that is based partly on the potential growth of an out-side index (excluding dividends). At the same time, none of the policyholder’s cash value participates directly in an equity market. This probably provides better long-term values than a fixed universal life product can provide. It also creates less risk to principal than a variable universal life product brings.
There is a way to avoid losing the death benefit as interest accrues. Special insurance riders increase the death benefit each year by the amount of interest on the pre-mium finance loan. This is called a“return-of interest/cost of money rider.”The death benefit will not get eaten away by accrued interest when combined with a standard return-of-premium rider. Ben-eficiaries always receive the original death benefit.
In short, premium financing can allow your client to protect their net worth and pass along their financial legacy to future generations without altering other financial strategies.
––––––––––
Lance Wallach, CLU, ChFC, the National Society of Accountants Speaker of the Year, speaks at more than 70 national conventions annually and writes for more than 50 national publications about financial planning, retirement plans, and tax reduction. For more information, visitwww.vebaplan.com or call 516-938-5007.
TAX MATTERS: ABUSIVE INSURANCE PLANS GET RED FLAG
ABUSIVE INSURANCE PLANS GET RED FLAG
The IRS in Notice 2007-83 identified as listed transactions certain trust arrangements involving cash-value life insurance policies. Revenue Ruling 2007-65, issued simultaneously, addressed situations where the tax deduction has been disallowed, in part or in whole, for premiums paid on such cash-value life insurance policies. Also simultaneously issued was Notice 2007-84, which disallows tax deductions and imposes severe penalties for welfare benefit plans that primarily and impermissibly benefit shareholders and highly compensated employees.
Taxpayers participating in these listed transactions must disclose such participation to the Service by January 15. Failure to disclose can result in severe penalties--- up to $100,000 for individuals and $200,000 for corporations.
Ruling 2007-65 aims at situations where cash-value life insurance is purchased on owner/employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419(f) (6), and 419 plans. Other arrangements described by the ruling may also be listed transactions. A business in such an arrangement cannot deduct premiums paid for cash-value life insurance.
A CPA who is approached by a client about one of these arrangements must exercise the utmost degree of caution, and not only on behalf of the client. The severe penalties noted above can also be applied to the preparers of returns that fail to properly disclose listed transactions.
Prepared by Lance Wallach, CLU, ChFC, CIMC, of Plainview, N.Y.,
516-938-5007, a writer and speaker on voluntary employee’s beneficiary associations and other employee benefits.
The IRS in Notice 2007-83 identified as listed transactions certain trust arrangements involving cash-value life insurance policies. Revenue Ruling 2007-65, issued simultaneously, addressed situations where the tax deduction has been disallowed, in part or in whole, for premiums paid on such cash-value life insurance policies. Also simultaneously issued was Notice 2007-84, which disallows tax deductions and imposes severe penalties for welfare benefit plans that primarily and impermissibly benefit shareholders and highly compensated employees.
Taxpayers participating in these listed transactions must disclose such participation to the Service by January 15. Failure to disclose can result in severe penalties--- up to $100,000 for individuals and $200,000 for corporations.
Ruling 2007-65 aims at situations where cash-value life insurance is purchased on owner/employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419(f) (6), and 419 plans. Other arrangements described by the ruling may also be listed transactions. A business in such an arrangement cannot deduct premiums paid for cash-value life insurance.
A CPA who is approached by a client about one of these arrangements must exercise the utmost degree of caution, and not only on behalf of the client. The severe penalties noted above can also be applied to the preparers of returns that fail to properly disclose listed transactions.
Prepared by Lance Wallach, CLU, ChFC, CIMC, of Plainview, N.Y.,
516-938-5007, a writer and speaker on voluntary employee’s beneficiary associations and other employee benefits.
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